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Commodity Channel Index
This technical tool was developed by Donald Lambert who was interested in identifying the cycle turning points in the markets. Cycles are well known and quite often are evident in the markets however; it is often difficult to identify a cycle length and its termination. Donald Lambert suggested adjusting time frame for the cycle using 1/3rd of the particular cycle length. Common cycle lengths are:
- 18 day cycle use 6 periods
- 30 day cycle use 10 periods
- 90 day cycle use 20 periods
- 360 day cycle use 80 periods
Cycle periods are taken from low to low ideally however it is often the case that separate cycles are correlated to the extent that as a shorter term cycle is turning down, a larger term cycle is turning up which creates the illusion that the shorter term cycle has disappeared. Lambert recommended a 20 period as the norm.
A basic market truth - All price breakouts begin from a period of low volatility.
Like Bollinger bands, the CCI uses standard deviation in the formula and this aspect of the indicator allow a productive marriage between the two. A 20 period CCI zero line is congruent with the Bollinger Band 20 period moving average. If price is on the 20 period moving average used to construct the Bollinger Bands, the CCI bars will be on the indicator zero line.
The steps in the process required to construct the CCI:
- Calculate the last price. Lambert recommends using the (High+Low+Close)/3.
- Construct a 20-period Simple Moving Average of the price as calculated in 1 above.
- Calculate the Mean Deviation. This requires that each different value between the SMA and the calculated price be added together and divided by 20. The result is the mean
deviation.
- These are then applied using the formula shown in addition to a constant of 0.015,
recommended by Lambert.
- CCI = (((H+L+C)/3) – SMA value) / (0.015 X MD)
Alternatively, most charting software can produce the required result.
The 0.015 constant was devised by Lambert and is intended to contain up to 80% of the indicator activity between Plus 100 and Minus 100. How successful this will be depends on the periods used. High periods will see more of the indicator action contained and shorter periods will express more volatility represented by a more frequent appearance outside the +100 and _100 references.
Donald Lambert published a guide to trading the CCI that suggested selling into a break below the +100 band and buying a break above the -100 band. Tests using these rules will likely lead to the assumption that an additional filter or filters is required.
Suggested techniques include only taking the trades in the direction of the trend. The trend may be determined by visual inspection, above or below a 60 period moving average or two consecutive lower lows or higher highs. The best trades occur when the CCI is used in conjunction with Bollinger bands and reference points. When multiple singles are given for a trade, the noise bands can be reduced is size. Using the training provision if provided in the users software is a good start to testing concepts.
Some 70 to 80 percent of the CCI values are between +100 and -100, and consequently price action external of the +100 and -100 parameters will only be 20% to 30% of the time. The trading strategy that can be looked at is a buy when the CCI moves above +100, closing out the trade when the CCI moves below the +100 reference. A move by the CCI below the -100 reference signals a sell buying back when the CCI moves back above the -100 band. Again filters are appropriate. 
The 60 period moving average defines the trend as up or down. The trade shown was able to
use a 2% band rather than a 5% band because the Bollinger Bands were starting to expand
out of a contracted condition, the CCI histogram bar had risen above +100 and price broke
through the reference band.
The other major feature of the CCI is the ability of the indicator to produce divergence
signals. The CCI measures and portrays the extent of the deviation of the price from its
average. Above +100 suggests that the price is unusually high compared with the average and
below -100 suggests the price unusually low.
The mathematical structure causes the increasing deviation to become negatively correlated
with the underlying price action causing the indicator direction to move opposite to price.
These leading indications of price change become valuable information as to the condition of
the market.
Experimenting with various time frames can also throw light on the present market condition
compared to the past. 
The weekly chart above is the All Ordinaries Index with three CCI’s set to 52 weeks, 20 weeks and 10 weeks.
The 52 week histogram remains above the central zero line for the whole period of the rise.
An assumption could be made that a fall below zero signals the end of the price action that
saw it hold above for so long.
The 20 period CCI shows the bearish divergence to a greater extent than the other two time
frames. Both the 10 period and the 20 period provide good entry signals for entering or reentering
the rising market. 
The period shown on the price chart is the November 1992, 1000 point rise to February 1994 peak and the decline to November 1994, 141/2 months up and 91/2 months down. The ability of each time frame to provide some insight is evident.
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